macro
CHAPTER ONE
The Science of
Macroeconomics
macroeconomics
fifth edition
N. Gregory Mankiw
PowerPoint® Slides
by Ron Cronovich
© 2003 Worth Publishers, all rights reserved
Learning objectives
This chapter introduces you to
 the issues macroeconomists study
 the tools macroeconomists use
 some important concepts in
macroeconomic analysis
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The Science of Macroeconomics
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Important issues in macroeconomics
 Why does the cost of living keep rising?
 Why are millions of people unemployed,
even when the economy is booming?
 Why are there recessions?
Can the government do anything to combat
recessions? Should it??
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Important issues in macroeconomics
 What is the government budget deficit?
How does it affect the economy?
 Why does the U.S. have such a huge trade
deficit?
 Why are so many countries poor?
What policies might help them grow out of
poverty?
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U.S. Gross Domestic Product
in billions of chained 1996 dollars
10,000
9,000
8,000
7,000
6,000
5,000
4,000
3,000
1970
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1975
1980
1985
1990
1995
The Science of Macroeconomics
2000
slide 4
U.S. Gross Domestic Product
in billions of chained 1996 dollars
10,000
longest economic
expansion on record
9,000
8,000
7,000
Recessions
6,000
5,000
4,000
3,000
1970
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1975
1980
1985
1990
1995
The Science of Macroeconomics
2000
slide 5
Why learn macroeconomics?
1. The macroeconomy affects society’s well-being.
 example: Unemployment and social problems
Each one-point increase in the u-rate is associated with:
 920 more suicides
 650 more homicides
 4000 more people admitted to state mental
institutions
 3300 more people sent to state prisons
 37, 000 more deaths
 increases in domestic violence and homelessness
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Why learn macroeconomics?
%
2. The macroeconomy affects your well-being.
 Unemployment and earnings growth
5
4
3
2
1
0
-1
-2
-3
-4
-5
1965
1970
1975
1980
1985
1990
1995
2000
growth rate of inflation-adjusted hourly earnings
change in Unemployment rate
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Why learn macroeconomics?
2. The macroeconomy affects your well-being.
 Interest rates and mortgage payments
For a $150,000 30-year mortgage:
date
actual rate
on 30-year
mortgage
monthly
payment
annual
payment
6/21/02
6.63%
$960
$11,520
6/20/03
5.21%
$824
$9,888
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Why learn macroeconomics?
3. The macroeconomy affects politics & current events.
 Inflation and unemployment in election years
year
U rate
inflation rate
1976
7.7%
5.8%
Carter (D)
1980
7.1%
13.5%
Reagan (R)
1984
7.5%
4.3%
Reagan (R)
1988
5.5%
4.1%
Bush I (R)
1992
7.5%
3.0%
Clinton (D)
1996
5.4%
3.3%
Clinton (D)
2000
4.0%
3.4%
Bush II (R)
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elec. outcome
The Science of Macroeconomics
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Economic models
…are simplified versions of a more complex
reality
• irrelevant details are stripped away
Used to
• show the relationships between economic
variables
• explain the economy’s behavior
• devise policies to improve economic
performance
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Example of a model:
The supply & demand for new cars
 explains the factors that determine the price of
cars and the quantity sold
 assumes the market is competitive: each buyer
and seller is too small to affect the market price
 Variables:
Q d = quantity of cars that buyers demand
Q s = quantity that producers supply
P = price of new cars
Y = aggregate income
Ps = price of steel (an input)
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The demand for cars
demand equation:
d
Q  D (P ,Y )
shows that the quantity
of cars consumers demand
is related to the price of cars
and aggregate income.
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Digression: Functional notation
 General functional notation
shows only that the variables are related:
Q d  D (P ,Y )
A list of the
variables
that affect Q d
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Digression: Functional notation
 General functional notation
shows only that the variables are related:
Q d  D (P ,Y )
 A specific functional form shows
the precise quantitative relationship:
Examples:
1)
2)
Q d  D (P ,Y )  60  10P  2Y
d
Q  D (P ,Y ) 
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0.3Y
P
The Science of Macroeconomics
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The market for cars: demand
demand equation:
Q
d
 D (P ,Y )
P
Price
of cars
The demand curve
shows the relationship
between quantity
demanded and price,
other things equal.
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D
Q
Quantity
of cars
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The market for cars: supply
supply equation:
s
Q  S (P , Ps )
P
Price
of cars
The supply curve
shows the relationship
between quantity
supplied and price,
other things equal.
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S
D
Q
Quantity
of cars
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The market for cars: equilibrium
P
Price
of cars
S
equilibrium
price
D
Q
equilibrium
quantity
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The Science of Macroeconomics
Quantity
of cars
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The effects of an increase in income:
demand equation:
Price
of cars
Q d  D (P ,Y )
An increase in income
increases the quantity
of cars consumers
demand at each price...
…which increases
the equilibrium price
and quantity.
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P
S
P2
P1
D1
Q1 Q2
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D2
Q
Quantity
of cars
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The effects of a steel price increase:
supply equation:
s
Q  S (P , Ps )
S2
Price
of cars
An increase in Ps
reduces the quantity of
cars producers supply
at each price…
…which increases the
market price and
reduces the quantity.
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P
S1
P2
P1
D
Q2 Q1
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Q
Quantity
of cars
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Endogenous vs. exogenous variables:
 The values of endogenous variables
are determined in the model.
 The values of exogenous variables
are determined outside the model:
the model takes their values & behavior
as given.
 In the model of supply & demand for cars,
d
endogenous:
P, Q , Q
exogenous:
Y , Ps
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Now you try:
1. Write down demand and supply
equations for wireless phones;
include two exogenous variables
in each equation.
2. Draw a supply-demand graph
for wireless phones.
3. Use your graph to show how a
change in one of your exogenous
variables affects the model’s
endogenous variables.
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A multitude of models
No one model can address all the issues we
care about. For example,
 If we want to know how a fall in aggregate
income affects new car prices, we can use
the S/D model for new cars.
 But if we want to know why aggregate
income falls, we need a different model.
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A Multitude of Models
 So we will learn different models for studying
different issues (e.g., unemployment, inflation,
long-run growth).
 For each new model, you should keep track of
– its assumptions,
– which of its variables are endogenous and
which are exogenous,
– the questions it can help us understand,
– and those it cannot.
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Prices: flexible versus sticky
 Market clearing: an assumption that prices
are flexible and adjust to equate supply and
demand.
 In the short run, many prices are sticky--they adjust only sluggishly in response to
supply/demand imbalances.
For example,
– labor contracts that fix the nominal wage
for a year or longer
– magazine prices that publishers change
only once every 3-4 years
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Prices: flexible versus sticky
 The economy’s behavior depends partly on
whether prices are sticky or flexible:
 If prices are sticky, then demand won’t
always equal supply. This helps explain
– unemployment (excess supply of labor)
– the occasional inability of firms to sell what
they produce.
 Long run: prices flexible, markets clear,
economy behaves very differently
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Outline of this book:
 Introductory material
 Classical Theory
(Chaps. 1 & 2)
(Chaps. 3 to 6)
How the economy works in the long run,
when prices are flexible
 Growth Theory
(Chaps. 7 to 8)
The standard of living and its growth rate
over the very long run
 Business Cycle Theory
(Chaps 9 to 13)
How the economy works in the short run,
when prices are sticky
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Outline of this book:
 Policy debates
(Chaps. 14 to15)
Should the government try to smooth business
cycle fluctuations? Is the government’s debt a
problem?
 Microeconomic foundations
(Chaps. 16 to 19)
Insights from looking at the behavior of
consumers, firms, and other issues from a
microeconomic perspective
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Chapter summary
1. Macroeconomics is the study of the
economy as a whole, including
• growth in incomes,
• changes in the overall level of prices,
• the unemployment rate.
2. Macroeconomists attempt to explain the
economy and to devise policies to improve
its performance.
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Chapter summary
3. Economists use different models to
examine different issues.
4. Models with flexible prices describe the
economy in the long run; models with
sticky prices describe economy in the short
run.
5. Macroeconomic events and performance
arise from many microeconomic
transactions; so macroeconomics uses
many of the tools of microeconomics.
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